The Psychology of Pricing (Is there such a thing as Fair Market Value?)

The Psychology of Pricing (Is there such a thing as Fair Market Value?)

Jul 16, 2014

Price is the quantity of payment or compensation given by one party to another in return for goods or services. The price of something reflects the value that we attach to it. Ideally, the equilibrium price should include the cost of producing and shipping the good or service plus an acceptable profit. However, the truth is there’s so much more that goes to pricing and a lot of it has to do with psychology.

What is the price that makes the customer buy? The common quick answer would be the lower the price the higher the demand. This is why a lot of prices end with the digit 9. A P99 meal looks so much cheaper than a P100 meal. Back in the day, our prices were expressed to the last 5 centavos so that would have been P99.95 but we hardly use the 5 centavo coin so we now price goods at P99.75. This odd pricing is used because the human brain tends to round off or anchor the price to the lower monetary unit. Whether your agree or not, the lazy brain thinks of the 90s rather than the 3-digit number 100 that it should be rounded off to; hence, it looks and feels cheaper.

However, not everything is preferred cheaper. There are some goods and services that customers actually want to pay more money for. Of course, they don’t say this explicitly. But there are studies that prove this. The same wine, for instance, is preferred by the subjects when priced higher. In other words, paying a higher price adds to the utility or satisfaction of the customer. Even medicines seem to elicit a placebo effect just by pricing it a bit higher.

The human mind, in its irrational glory, still insists that it is rational at least most of the time. So what it does is it looks for little proofs here and there to convince itself that it made the right decision – e.g. the more expensive wine, medicine, etc. are really better than the cheaper ones.

This psychology of pricing is highly evident in luxury items. There is an entire science and art that go into the pricing of luxury items. It’s true that the raw materials and the labor used in producing these items are of higher quality but a huge part of the bloated price is due to the psychology of it all. The manufacturers of these items have to make sure that they hit the right price point at which their customers will continue to feel the exclusiveness of their products as they rationalize their expensive purchases. Of course, it’s also a status symbol to be strutting around with these items. Hence, the manufacturers have to exclude the lower income segments of society among their buyers in order to keep this image.

Although my Ilocano blood still actively flows in my veins, I must admit that I enjoy the feel of luxury once in a while. I like good service and sometimes I value this more than a tangible item with a big screaming logo.

Recently, my husband and I had our search for shoes for a very important occasion we’re about to celebrate. Our respective experiences have made me think about the psychology of pricing. He was looking for charol shoes, as suggested by the designer of his outfit. He saw a nice pair of Italian shoes, which were expectedly priced high. He hesitated to buy because he knew that he wouldn’t be wearing charol shoes very often so he won’t be able to “amortize the cost.” Then he saw another pair, which, according to him, looked and “felt Italian” when he tried it on. But they were not charol. Feeling experimental, he asked if they could do custom-made shoes. He was referred to another shoemaker and he ordered a pair of charol shoes for a small fraction of the Italian brand – i.e. less than 1/10! Well, the verdict will still come out when he finally gets them in the next few days.

On my part, I was looking for a strappy silver pair. I have positive experiences with Via Venetto. There was a pair of pumps that lasted me for over a decade during my corporate outfit days. This was such a great buy because my friend was even able to get a 30% discount for me from the store. I also remember buying a nice silver strappy pair in 1999. The price was on the high end, especially for local shoes, but there was a tug in my heart that made me buy it. I’ve worn it to so many formal occasions and just said goodbye to it last year. So definitely, my first stop was this store. Unfortunately, the available choices didn’t excite me at all. No tug in my heart this time. So I went to all the other shoe stores in the mall in search of my silver strappies. I must have tried on over a dozen pairs. And it was not easy. You see, the nice pairs seem to come in 5 inches high heels and this ‘80s lass, who grew up in flats and managed to wear only 2-2.5 inch heels in her corporate days, is no match to those high heels. Add to that the fact that my feet are quite small –  at 5’3’’ tall, my shoe size is only 5 ½ for sandals so I’m literally tip-toeing in 5-inch heels.

But I was bent on getting that pair soon so I went on with my search, one store at a time, patiently looking and trying, sometimes with matching feet selfies to aid comparison. Then I saw this pair, which wasn’t really tugging my heart but was growing on me as I walked around in it. It felt comfortable enough at probably a little less than 3 inches high, no platform. Then I looked at the price. Would you believe I hesitated to buy because I thought it was too cheap? I had a price range in mind and it was way below it. So I imagined, would this conk out on me while I walk or dance maybe? Also, maybe my mind was set on a higher price because of the value that I’m attaching to the occasion.

Not finding an “equilibrium” in the price and the special occasion, I went around again to look for other options. But each time I tried on another pair, I was more convinced that the cheaper pair was the best. The others were comfy but I looked like I was going to a ballroom dance competition with a D.I.! So after a few more stores and two more fittings of the cheaper pair, I tried to assess objectively, “If this pair were priced the same as the rest, would I buy it?” When I answered “Definitely!” I finally decided to buy it. When the salesperson put it in its box, I was pleasantly surprised that each shoe even had its own bag and fillings, which he neatly arranged inside the box.

Pricing is tricky

Pondering on the psychology of pricing makes me wonder whether there really is such a thing as the fair market value that’s universally acceptable. Prices of different stocks in the market are a good example. Company A continues to sell at a high PE (price earnings ratio) while company B in the same business is selling at half that PE for no compelling reason. Analysts may use all their magic tricks up their sleeves to rationalize high PEs, but in the end, it’s really the summation of all the underlying psychology of all the market players that convinces the market to price a stock at a certain level. Being aware of this reality instead of insisting on the rationality of the market (with its human players) may prove to be advantageous to investors.

But that’s just money. The value of money is relative to each person. The value of P1,000 to person A is not the same as that to person B. And this is why each purchase, especially on non-essentials, should be valued not in relation to what your neighbors buy but what you can afford and are happy with.

The universally valuable commodity

However, if there’s one commodity that we associate with value and is not relative but somewhat constant to all individuals, it’s TIME. The billionaire next door has exactly the same number of hours in a day as the mendicant on the street. Therefore, this is the commodity that we have to be very prudent with in the way we use it. Know what’s most valuable to you. And make sure you spend most of your time on it.